In 2000, Buffett was asked by a Berkshire Hathaway shareholder to explain why he did not buy any internet stock. Recall that at that time, internet stocks were the rage. Buffett, however, had refused to participate in the speculative mania and Berkshire Hathaway’s stock price had hugely under-performed stocks of the internet companies. Some media reports even accused him of having “lost it” by not investing in the businesses of the future.
Buffett used the tool of “proof by contradiction” to demonstrate the silliness of the market at that time.
He said: “When we buy a stock, we always think in terms of buying the whole enterprise because it enables us to think as businessmen rather than stock speculators. So let’s just take a company that has marvellous prospects, that’s paying you nothing now where you buy it at a valuation of $500 billion. If you feel that 10% is the appropriate return and it pays you nothing this year, but starts to pay you next year, it has to be able to pay you $55 billion each year – in perpetuity. But if it’s not going to pay you anything until the third year, then it has to pay $60.5 billion each per year – again in perpetuity – to justify the present price… I question sometimes whether people who pay $500 billion implicitly for a business by paying some price for 100 shares of stock are really thinking of the mathematics that is implicit in what they’re doing. For example, let’s just assume that there’s only going to be a one-year delay before the business starts paying out to you and you want to get a 10% return. “If you paid $500 billion, then $55 billion in cash is the amount that it’s going to have to disgorge to you year after year after year. To do that, it has to make perhaps $80 billion, or close to it, pretax. Look around at the universe of businesses in this world and see how many are earning $80 billion pretax – or $70 billion or $60 or $50 or $40 or even $30 billion. You won’t find any…”
Masterstroke by buffet !!!
Investor Warren Buffett took a pasting for ignoring the 1999-2000 surge in dot.com stocks. After the bubble burst, he enjoyed the last laugh
Value is destroyed, not created, by any business that loses money over its lifetime